Question: Money supply, money demand and price levels?
(a) Explain the adjustment process that creates a change in the price level when the
money supply increases. [5 marks]
(b) Explain with the aid of a diagram what happens to the money supply, money
demand, the value of money, and the price level if the central bank increases the
money supply. [5 marks]
(c) Explain with the aid of a diagram what happens to the money supply, money
demand, the value of money, and the price level if people demand less money at
every price level. [5 marks]
Best answer:
Answer by bachfan
a) When the money supply increase, the vertical money supply curve will shift to the right, decreasing the nominal interest rate. As a result, with a lower nominal interest rate, people tend to consume more since saving money in banks wouldn't benefit much. Hence, aggregate demand curve shifts to the right, increasing the price level.
b) Money supply: increase
Money demand: no direct relationship with changes in money supply
Value of money: Decrease (since increase in price level, i.e. inflation, leads to decrease in
purchasing value of money)
Price level: Increase
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